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Exam 4 Chapter 10

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gasucaxa's version from 2017-03-16 14:33

Definitions And Concepts Chapter 10

Question Answer
Three primary functions of government in the economy –allocation function, distribution function, and stabilization function
allocation function –government production of goods or regulation of business, aimed at improving the allocative efficiency of the economy (i.e., getting the “right mix” of products produced, each in the “ideal quantity” and at the “ideal quality”).
distribution function –government policies aimed at changing the final distribution of goods/services across consumers, usually with the intention of realizing a “fairer” apportionment of consumption/income/wealth.
stabilization function –attempts by government to minimize fluctuations in overall macroeconomic activity.
market failure –a situation in which the “free market outcome” is inefficient, in that there is a positive Deadweight-Loss at the resulting “free market level of trade.”
four common sources of market failure –(1) profit maximization by a firm with market power, (2) market provision of public goods, (3) market provision of goods generating externalities, and (4) lack of information by market participants market power A firm has market power if they have some “control over the price of their output,” in that they: (i) can increase price without losing all customers and (ii) must decrease price in order to increase sales
monopoly –market structure in which there is one single seller of a unique good with no close substitutes. The “polar opposite” of “perfect competition.” The demand curve facing a monopolist is the market demand curve. They can choose any price/quantity combination along the market demand curve.
profit –the difference between revenues and costs of production
marginal revenue –the amount by which revenue changes as the firm’s quantity of output is increased by a unit
marginal costs of production –the amount by which production costs change as the firm’s quantity of output is increased by a unit
non-rival good –a good for which consumption by one person does not diminish the quantity or quality of consumption by others
rival good –a good for which consumption by one person does diminish the quantity or quality of consumption by others
non-excludable good –a good for which it is difficult (or very costly) to prevent consumption by those who do not pay
excludable good –a good for which it is easy to prevent consumption by those who do not pay
private good –a good that is excludable and rival in consumption. e.g., Big Mac from McDonald’s; market provision is typically efficient
public good –a good that is non-excludable and non-rival in consumption e.g., national defense
club good –a good that is excludable and non-rival in consumption e.g., satellite radio or television broadcast
common good –a good that is non-excludable and rival in consumption e.g., stock of fish in the ocean
free rider problem –if a public good were supplied in a free market, the amount traded would be less than the efficient quantity, since many people would attempt to enjoy the benefits of units purchased by others, while not purchasing any units themselves
externality –a benefit or cost that is realized by someone who is not directly engaging in an activity
negative externality –a cost of an activity borne by someone not engaging in the activity. examples: pollution, noise from low-flying aircraft, speeding on a highway, installation of “The Club” in a car
positive externality –a benefit from an activity realized by someone not engaging in the activity examples: vaccines, installation of smoke detector in an “attached apartment,” installation of Lojack in a car
market failure due to lack of information –for some goods consumers may have difficulty knowing their “true reservation price” => especially common for goods purchased infrequently or for which quality is difficult to observe (e.g., house, car, education, medical procedure, meal at a restaurant)
memorize

Coasian solution to the problem of externalities

Question Answer
Coasian solution to the problem of externalities –Ronald Coase Noble Prize in 1991; Professor Emeritus at Univ. of Chicago Law School) argued that problems of externalities are at their core due to undefined property rights and can be address by the following approach:
i –clearly and fully define property rights
ii –make individuals pay compensation if they infringe upon the property rights of others
iii –allow parties to negotiate with one another regarding infringements on property rights caused by the externality
Coase showed that regardless of which party is given the property right negotiation between the parties will result in the efficient level of the externality –(so long as the costs of negotiation and enforcement are low enough)
defining property rights and allowing parties to negotiate essentially –“internalizes the externality”
memorize

Potential policies to reduce the DWL associated with a “negative externality”

Question Answer
1. ban the activity entirely –(“illegal to emit any pollution”)
2. establish minimum compliance standards for manufacturers –(“can only pollute up to a certain level”)
3. “cap and trade” –issue a certain number of “pollution permits” for society as a whole, and allow people to trade these permits amongst themselves
4. offer subsidies to manufacturers that reduce pollution –(“pay the polluter to reduce their level of pollution”)
5. charge manufacturers a fee for each unit of pollution emitted –(“polluter must pay for the right to pollute”)
memorize

 

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